The critical question raised by the crisis that has enveloped Centro – and, indeed, the broader sub-prime crisis that forms the backdrop to Centro’s problems – is whether we are witnessing a liquidity issue or an insolvency issue.
Centro has gone a long way to reassuring the market that it is grappling only with a liquidity issue rather than trying to stave off insolvency, essentially saying there were no trigger events for a default and stating its confidence in the viability of its business after reviewing its cash flows. It says there are no default or ‘’margin call’’ provisions within the loan agreements triggered by the collapse in the group’s security prices.
Most significantly, Centro said it was not obliged to take any specific course of action before the February 15 extension of its short term debt facilities looms – it needs only to develop a strategy that reassures its bankers.
The statement had an immediate and pronounced – and unequivocally positive -- impact on the price of its securities, which had been trading within an increasingly pessimistic information vacuum. The market, for the moment, is ascribing more than $1 billion of value to Centro Properties and nearly $2 billion to Centro Retail, which is a big endorsement of its survival prospects.
That is not to say, however, that Centro can somehow sell a few properties and return to business-as-usual – although it probably will have to sell a few properties and/or some of its interests in its managed funds in order to create internal liquidity in circumstances where external liquidity isn’t available.
If it gets beyond the survival issues, Centro will have to rethink and rebuild a business model that worked very well in good times but has worked against it under pressure.
At best, that means Centro goes from being a growth business to being one that has to shrink and consolidate, which has very significant implications for the value of its service businesses and management contracts.
Unless its bankers panic, however – and it would be almost suicidal for them to destabilise any further a group with more than $26 billion of assets and $18 billion of debts in such nervous times – it appears possible to deal with the liquidity crisis without in the process tipping Centro into an insolvency crisis.
Underlying Centro’s woes is a portfolio of more than 800 shopping centres in Australia and the US – mainly regional centres and therefore inherently defensive and resilient. To regain control of its own destiny Centro is probably going to have to sell some of those centres .
The US is at the epicentre of the global financial uncertainty and because Centro has also probably overpaid (in the context of what is now occurring in the US) in its relatively recent and quite aggressive expansion into that market, it will probably have to sell some of its best Australian centres at less-than-optimal prices. However it might have represented itself, it is a distressed and urgent seller if it wants to get itself beyond the clutches and whims of its bankers.
In a market where quality retail centres aren’t readily available, however, it is likely to attract significant interest and, get reasonable value for its assets.
The challenge then, given the complex structure of the group and the number of disparate interest groups in each segment of the Centro equity chain, will be to devise mechanisms for up-streaming the cash from the asset-owning vehicles and getting into the head stock, where the most-offending debt lies. The inefficiency of the structure when under pressure probably means Centro is going to have to sell several billion dollars of assets, if not more, to get its bankers off its back.
The Centro experience encapsulates the knife-edge on which a lot of financial services businesses are balancing.
In the US, and elsewhere (including this market) the sub-prime crisis has resulted in insolvencies and mortgage defaults and no doubt will produce more. It has also triggered a global credit crunch and consequent liquidity squeeze for financial institutions and non-financials alike. There is a fine line between a liquidity crisis and insolvency – if the liquidity can’t be generated insolvency inevitably beckons.
The grey area between the two is exacerbating the global tightening of liquidity because banks and other financial institutions are scared to lend to each other, let alone anyone else, in case their counter-parties experience something worse than liquidity issues.
In Centro’s case, it is in no one’s interest to see it punished excessively for exposing itself to the liquidity shock by allowing nearly $4 billion of short-term funding to remain in place until maturity. As easily the biggest distressed entity in this market, that gives it some leverage with its lenders, provided it moves quickly and decisively to reassure them.